Glut of off-lease vehicles makes it a good time to buy used

The number of new vehicles that were leased hit a record 4.4 million last year, triple the number in 2009, when auto sales were at their low point during the recession.

New- and used-car sales have increased seven years in a row as the economy has improved. That’s a streak not seen since the 1920s, but industry analysts worry that the used-car market might not be able to easily digest a record number of vehicles with expired leases being listed for sale.

Most leases are for 36 months, so three years after they leave dealerships, they come back as used cars, and in 2017, the auto industry is bracing for a record 3.6 million off-lease vehicles.

Michelle Krebs, senior analyst at Cox Automotive’s Autotrader, expects new-car sales to drop from a record 17.5 million in 2016 and for used prices to soften. She says more buyers are likely to cross-shop new vehicles against the glut of late-model used vehicles coming off leases, and many of those will wind up as certified pre-owned cars, which can cost on average about $1,500 more than typical used cars.

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“The market really expanded to accommodate the used cars on the market as well as record new-car sales, but now all that is softening. When we have new-car sales softening and this glut of used cars, we have an increased supply and lower demand, and used-car prices will be down,” Krebs said.

For consumers, the flood of off-lease vehicles could lower the prices on certified pre-owned cars and used cars in general, a boon for budget-conscious shoppers. That, however, could cut into new-vehicle sales and force manufacturers to hike incentives, which have been rising already.

“It’s hard to know how the nearly new or certified pre-owned cars will play against the new cars. We see a lot of cross-shopping between the two on our website, so will the consumer take that over a new car, or will the incentives get richer on new cars so that it makes more sense to buy new rather than nearly new?” Krebs said. “There are just a lot of dynamics going on, and we don’t know how it’s going to shake out.”

The flip side for consumers is that the glut of off-lease vehicles also could make buying or leasing a new vehicle more expensive. An oversupply of used cars could diminish the value of a vehicle they plan to trade in. If they’re leasing, lower used values translate to higher lease payments, Jessica Caldwell, senior analyst for Edmunds, said.

“The lease payment is predicated on the residual value, so if those start to decline, then lease payments will go up. If the payments go up, that will make it less attractive for people to want to lease. That is what we might see happen, that leasing will stagnate a bit this year,” Caldwell said.

Leased vehicles accounted for about 25 percent of total vehicle sales in 2016 and 31 percent of retail sales. Edmunds and Autotrader see leasing declining slightly this year to 30 percent of retail sales as manufacturers back off as a hedge against declining used prices. Manufacturers project what a leased vehicle will be worth after three years — the residual value. If the actual resale value is lower at the end of the lease, they lose money.

The flood of off-lease vehicles will continue to grow to more than 4 million vehicles in 2018. In addition, Manheim, a major used-car auction company, said that more than 1.8 million used rental cars will enter the used market this year, mainly 1- and 2-year-old vehicles.

With so many late-model used vehicles that could poach new-car shoppers, Krebs said Autotrader is forecasting that new-vehicle sales will fall into a range of 16.8 million to 17.3 million, at the lower end of most forecasts.

“A lot of forecasters do not take into account that we are going to see a huge number of off-lease vehicles come onto the market. It’s been climbing every year; it’s going to climb again this year and keep climbing through 2020 because leasing has been at record levels,” she said, and the auto industry had to stretch to reach 17.5 million vehicles in 2016.

“We had a record last year, but it came at some cost, because the incentives got so hefty and the promotions so big in December.”

Caldwell says used-car values in the aggregate will increase because of the influx of late-model used vehicles and because new-car transaction prices keep rising, but she said the industry will struggle to manage the higher volume of used vehicles.

“It will certainly be a challenge for dealers to absorb all the near-new used inventory, because it doesn’t sell as fast as the older vehicles. The older stuff sells very quickly,” she said. “That’s going to put a lot of pressure on used-car values, because the inventory just continues to climb.”

Moreover, if manufacturers continue to step up incentives on new cars, that will have a ripple effect on used cars. If new cars become less expensive because of higher discounts, used values fall proportionately.

“If incentives continue to climb, it would definitely prominently affect the near-new used vehicles,” Caldwell said.

As more new-car buyers spurn passenger cars in favor of SUVs and pickups, the used values of those vehicles react accordingly. Manheim said the wholesale auction values of compact cars dropped 5.6 percent in 2016 and midsize cars fell 3.7 percent. In comparison, the wholesale value of full-size pickups increased 4.3 percent.

“Used pickup trucks are in big demand,” Krebs said, and on Autotrader’s website, pickups are among the most sought-after used vehicles.

Used SUVs also have been in high demand and commanding high prices, yet wholesale values dropped 1.2 percent in 2016, according to Manheim.

“They had been in a situation where many hadn’t been available from off-lease, and they were selling every one they could get, and new ones weren’t getting discounted a lot,” Krebs said. “Now there are a lot more entries, everybody is getting real competitive in those segments and there are more incentives going. The (used SUV) supply is catching up with demand.”

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